The Gilmo Report

May 4, 2014

May 3, 2014

The market is having trouble generating any real upside thrust at this stage of the rally attempt off of the lows of mid-April that were established when the NASDAQ Composite Index, shown below on a daily chart, bounced off of its 200-day moving average. As I’ve been writing in recent reports, the grinding rally up off of those lows is quite logical given how deeply oversold many former leading stocks had become and their positions within their overall chart patterns. The question with any reaction rally, however, is whether it can develop into something more significant. Sharp bounces in massively oversold former leaders can help drive upside in the indexes, but that alone is not enough to generate a fresh, new rally phase.

While the small handful of long ideas I discussed in my report of this past Wednesday are doing okay, the fact is that the market indexes seem to mask what is truly a great deal of turmoil under the surface, and continued progress on the long side of this market remains an open question. While I remain open to the long side of this market, I would like to see more confirmation in the form of a broad swath of new buy set-ups, particularly among “new merchandise” types of names. So far, if one is trying to make a case for the long side, the pickings in this regard remain rather slim to non-existent. The NASDAQ is now in the 13th day of a rally attempt without any sign of a follow-through, and so far the overall action strikes me as a “right shoulder rally” and not much else. Meanwhile, the 65-day exponential moving average, the black moving average on my daily charts, has provided meaningful upside resistance as the index stalls and sputters at the line.


GR050414-NAZ Daily


If we take a longer view of the NASDAQ’s on a weekly chart, below, we can see the index forming a big head and shoulders formation with the current rally off of the mid-April lows serving to form what so far looks like a right shoulder. I should emphasize that I don’t rely on H&S formations in the indexes as being necessarily indicative of future direction, but in this case we can also look at individual stocks and see that many are mimicking the action in the NASDAQ by engaging in right shoulder rallies of their own. More on this a little later in the report.


GR050414-NAZ Weekly


The divergence that currently exists between the NASDAQ and the NYSE-based indexes, the S&P 500 Index and the Dow Jones Industrials, both of which have pushed right up against their early April highs, strikes me as cautionary at best and outright bearish at worst. The divergence strikes me as more indicative of money continuing to flow into defensive areas and bigger-cap, slower, more stable names. Interestingly, the Dow actually made an all-time closing high on Wednesday, something that I failed to mention in my last report, while the NASDAQ still remains well below its 50-day moving average. Both indexes, however, are churning and stalling up near the peaks, as we can see on the daily chart of the S&P 500, below. Friday’s jobs report, while representing a nominal upside surprise, underscored how dicey the current employment situation and the economy actually are. Remember that the Fed had, under then-Fed Chairman Ben Bernanke, made it clear that 6.5% unemployment represented a threshold at which they would consider it “safe” to end QE and begin raising interest rates. Now we are under that level with the latest unemployment rate coming in at 6.3%, but the Fed realizes that this is a phony number given that the lower unemployment number was fully a function of a record 806,000 people leaving the work force in April.


GR050414- SPX Daily


Adding some confirmation to my theory of a primarily-defensive rotation driving the upside in the S&P 500 is the fact that nobody seems to want the small-cap stocks, the proverbial “risk-on” component of the market. The iShares Russell 2000 (IWM) ETF, shown below on a daily chart, serves as a proxy for the Russell 2000 Index of small-cap stocks, and in contrast to the NASDAQ the Russell is still bouncing along its 200-day moving average. The small-caps clearly lack the upside thrust of their larger-cap brethren at this stage of the rally attempt, and if the market is truly setting up for a rally resumption I think we will have to see some serious improvement in the Russell 2000’s price/volume action.




Netflix (NFLX), which in my view is still in the process of working on right shoulders rallies, pushed right up into its 200-day moving average yesterday, something I more or less expected it to do based on my discussion of the stock in my Wednesday report. The stock is also running into its 10-day and 20-day moving averages, so I’m okay with re-entering on the short side here with the idea of keeping a tight stop at or just above the 200-day line. There is always the possibility that the stock will continue higher, but it already gapped up once to the 65-day exponential moving average after a big earnings “surprise” that wasn’t. It’s not clear to me what might provide a catalyst for further upside from here up into the 65-day or 50-day lines outside of the market indexes finding a way to grind higher. Thus the 200-day moving average remains NFLX’s first significant test of the strength of this recent reaction rally that occurred after the stock undercut the 312.10 target low on Monday.




Facebook (FB) remains somewhat inconclusive as it continues to bounce along the lows of its current pattern, which, as we can see on the daily chart below has the look of a head and shoulders. The stock appears to run into consistent resistance at around the 62-64 price area. FB could be working on a new base, and so investors can sit tight until some sort of confirmation in the way of a bottom-fishing pocket pivot along the lows of any potential new base is forthcoming. FB pulled back slightly and held right at its 10-day moving average on Friday on declining selling volume, which could be seen as constructive. With other social-networking stocks falling by the wayside in a serious way, FB remains the big-stock leader in the space, and so one must remain objective here and be open to a possible bottom-fishing pocket pivot, if that were to occur.


GR050414-FB (AMZN) has been rallying after undercutting its 296.50 low from last October, but the rally lacks any meaningful buying volume. AMZN is pushing up into its 10-day moving average, which may be a point at which the stock could be shorted, although a move to the 20-day moving average at around 320 is possible. Ideally, I would most prefer to short a rally up into the 50-day moving average just above the 340 price level, something that is not necessarily out of the question IF the general market can continue to grind higher. Thus one might test short positions into a rally, but success is not necessarily guaranteed unless we see the general market roll over. Remember that failed reaction rallies generally will coincide with a failed rally attempt by the general market indexes, so this is something that must be monitored in real-time.




Pandora Media (P) is another one of these stocks that is rallying weakly after undercutting key lows from last year, as I discussed in my report of this past Wednesday. Ideally I think would-be short-sellers in P should look for a rally up to the 200-day moving average up around 28. The past two days have seen the stock run into near-term resistance at the 25 level, so it is possible to test a short position there with the idea of covering quickly if the stock continues to rally. But remember that I first began discussing P as a short-sale candidate when it was trading up around the 35 price level, and it dropped 38% from that level on an intraday basis on Monday of this past week. To some extent P is probably “played out” on the short side for now, and my intention here would be to simply keep it on my watch list with an alert closer to the 200-day line. Ultimately I think P can head to 19 or lower in a continued market correction should the general market indexes roll over.




Gilead Sciences (GILD), not shown, pulled back on Friday after streaking past its 50-day moving average this week, and on Thursday I tweeted that the stock might be shortable based on the fact that it had moved just over 5% above the 50-day line, something that is actually quite common for right shoulder allies. The stock, however, is moving into the higher reaches of its chart pattern and looks like it might just consolidate here for a while. On the other hand, Celgene (CELG), shown below on a daily chart, remains in the lower regions of its current big H&S formation and has rallied up into the  50-day moving average which has only recently dropped below the 200-day line for a bearish “black cross.” If you take the time to look at a chart of GILD, you will notice that it has not had a black cross as the 50-day line remains well above the 200-day line. So it’s a matter of going after the stocks that remain weakest. We can also look at my prior discussions of CELG where I point out the extreme weakness in the stock as it closed at or near the weekly lows five weeks in a row as the stock moved lower throughout most of March and early April. The daily chart below reveals a low-volume rally up into the 50-day moving average and the 150 price area where the neckline of CELG’s H&S formation lies. The 200-day line lies all of 3% above where CELG closed on Friday, so even if CELG rallied as far as the 200-day line it still remains within shortable range using a logical stop of 3-5% max.




Biogen Idec (BIIB) is also having some trouble getting any kind of upside going as it flounders along its lows of the past week. While the NASDAQ made upside progress over the past week, BIIB remained flat, so I might be enticed to short the stock on any rally up to the 290 price level since that has represented resistance for the stock over the past week. Ideally, however, I would like to short a rally up into the 65-day exponential moving average at 302.49 as that has presented a more formidable area of resistance for the stock over the past five weeks, as we can see on the daily chart below.




Visa (V) pushed a couple of percent past its 200-day moving average on Thursday, thanks to a “strong” earnings report from its cousin stock, MasterCard (MA). This remains within shortable range, but keep in mind that the stock is now on top of the 200-day line which actually served as support on Friday as the stock pulled back with the general market. The Thursday rally basically brought the stock up into the top of the gap-down “falling window” of two Fridays ago to “fill the gap” before the stock backed down to the 200-day moving average on Friday, as we can see on the daily chart below. Clear upside resistance looks to me like it lies at the top of the gap at around 208 and this is actually less than 2% of where V closed on Friday. If one shorts the stock here, then you want to see a breach of the 200-day line as confirmation of the stock’s continuing weakness.




I almost never hold a stock short going into earnings, and such was the case going into LinkedIn’s (LNKD) earnings report on Thursday after the close. As we can see on the daily chart, LNKD gave short-sellers who have been stalking the stock a great gift by actually trading up briefly at the open on Friday, at which point I considered the stock quite shortable, and I actually tweeted to members in real-time that I had taken a short position in LNKD when it was trading around 160 early in the day. The stock rewarded short-selling stalkers by quickly breaking down and closing at the lows of the day on very heavy selling volume. With LNKD now well below the prior downside target of 160.20, I see nothing but air between the current close and the 125-130 price area, which is where I think the stock is headed. For now the 160 level appears to represent solid resistance for the stock, and this also coincides with where the 10-day moving average was. We’ve been stalking LNKD on the short side for a while now, and recall that in one of my first reports of 2014 I gave the stock my “Short of the Year” designation (see December 31, 2013 report). Proof that sometimes it’s better to be lucky than good! J




As I scan the market for new short-sale set-ups, I notice a number of right shoulder rallies in a fair number of broken-down leaders. One group of names that catches my eye here are the gaming stocks. On Friday I watched Wynn’s Resorts Ltd. (WYNN) gap up and rally right up to its 50-day moving average on heavy volume after announcing “whopping” 14% earnings growth that apparently exceeded analysts’ estimates. Often times I have to wonder whether these earnings “surprises” are less a function of a company’s outstanding fundamental performances and more a function of just how inaccurate analysts are in projecting earnings and sales estimates. WYNN responded on Friday with a huge-volume gap-up move that looks pretty strong, but probably bears watching should it fail and form a right shoulder within a possible H&S top. The rally in WYNN, however, caused sympathy rallies in other gaming names that look perhaps a little more “juicy” on the short side.




At first I decided to test a small short position in WYNN on Friday as it pushed right up into the 50-day line, but this didn’t gain any traction on the downside. As I scanned through the charts of other stocks in the group in real-time I noticed that some of the other names in the group look somewhat less convincing on the upside as they appear to be forming right shoulders within broader H&S formations. One of these is Las Vegas Sands (LVS), shown below on a daily chart. After breaking down off of its peak in early March, LVS bottomed out in the latter part of March and since then has been ranging back and forth as it builds what look to me like a couple of right shoulders in a potential H&S formation. Friday’s sympathy rally following WYNN’s earnings “surprise” took LVS right up into its 50-day moving average where it churned and stalled at the line on roughly average volume. Thus LVS’s gap-up rally didn’t really have any significant buying interest behind it, and looks more like a set-up to me. The gap-up and churn move which shows up as a sort of little “star” on the daily chart, could represent an “evening star” sort of formation if LVS gaps lower on Monday. In any case, I see LVS as an early short using a stop at around the 82 price level or even at Friday’s intraday high at 81.25 if one wishes to keep things even tighter.




I’ve been watching big-stock Chinese internet name Baidu (BIDU) for some time now as it has worked on what may be a head and shoulders topping formation, as we can see on the weekly chart below. BIDU has had a long run since it came public in 2005, and analysts are still looking for big earnings growth going forward. I’ve seen estimates calling for annual earnings of $11.46 by 2017, but this strikes me as similar to AMZN which also has a huge annual earnings estimate of $19.43 for 2018. Of course, that big future estimate hasn’t kept AMZN from topping, so in a similar manner I will let BIDU’s price/volume action do the talking. On the weekly chart it might look like BIDU found some support of the lows of the week and closed at the peak of its weekly range on roughly average weekly volume.


GR050414-BIDU Weekly


If we drill down to the daily chart of BIDU, below, we can see that the week’s volume was driven by a big-volume breakdown on Monday followed by a wedging rally up to the 50-day moving average as we moved into the end of the week. Note the exceptionally weak volume on Friday as BIDU stalled right at the 50-day line as the stock appears to form what may be the peak of a right shoulder in the pattern. With the stock right at the 50-day line, this becomes shortable here using whatever stop one likes, but not more than 3-5% as is my policy with all short positions.




Last year I first discussed online real-estate directory firm Trulia (TRLA) as a short-sale target as it was building a head and shoulders top (see October 30, 2013 report) back in October of 2013. TRLA to some extent illustrates how these H&S tops play out. The initial small, compact, H&S close to the peak, which I’ve outlined in a thin dotted line now, becomes a big head in a much larger macro-H&S formation where the chop and slop action over the past five months forms what are so far three right shoulders in the pattern. TRLA came out with earnings and surprised analysts by beating estimates on Wednesday, and this sent the stock up for a couple of days right into what has been resistance at or near the peaks of the prior two right shoulders in the macro-H&S formation, as we can see on the daily chart, below.

I like this as a short closer to the 36 price level and above up to the 200-day line which is currently at 37.63. TRLA raised guidance on Wednesday, but the bottom line from my perspective is that the stock remains a high-P/E stock and the Wednesday earnings announcement did not produce any pocket pivots or other concrete buy signals in the pattern. Instead, TRLA continues to range about in the right side of this macro-H&S formation and its high P/E becomes a liability in any continuing market correction or worse. This is because in a bear market environment P/E ratios will rapidly compress, something we’ve witnessed in a number of P/E high-flyers over the past two months.


GR050414-TRLA Weekly


As I wrote on Wednesday, “The essential picture that I am trying to paint is one of a market that is in a logical position to rally.” So far that logic has held to some extent, but the thrust of the rally is lacking, and some of the action underneath the market’s hood strikes me as distinctly negative and shortable, such as the sharp breakdown in LNKD, for example. On the other hand, I have identified some buyable set-ups that I like in stocks like Alliance Fiber Optic (AFOP), Anika Therapeutics (ANIK), and Actavis Plc (ACT). Even Tesla Motors (TSLA) is holding up but I don’t really care to have a position in the stock going into Wednesday’s earnings report. While I don’t show any of these on charts here, all four have moved up slightly or better since I discussed them in this past Wednesday’s report.

Thus my approach here centers more on the idea of treating the market as a market of stocks and not a stock market that is characterized by a particularly strong trend, one way or the other. That can change, however, and I remain very alert on the short side as I see my short-sale target stocks stage what might very well turn out to be right shoulder rallies. At the same time, some new short-sale set-ups are starting to make it through my short screens. Meanwhile, nothing new shows up on my long screens. What has characterized prior market turns over the last year or more has been a steady improvement in leading stocks that includes the appearance of some new merchandise. Even before the market “follows through” and the rally resumption becomes obvious, leading and new merchandise leading stocks have flashed pocket pivots and other objective buy signals all over the place. We’re not seeing that here at the current time, and this is what makes me cautious on the long side. As well the divergence between the NYSE-based indexes like the S&P 500 and the NASDAQ Composites and its small-cap cohort, the Russell 2000, may be a bearish clue as to the eventual resolution of the market’s current and roughly two-week rally attempt off the lows of April 15th.

Based on my own experience, I can say that over the past two weeks, even as the general market has rallied off of the lows, I have made far more progress trading on the short side than trying to make money on the long side. I tend to think that if one would like to test the long side of this market then one should be open to the idea of taking a short-term view towards any upside progress that can be made until and unless the general market can show more meaningful upside thrust and the general underlying tone of the market with respect to “new merchandise” types of leadership moves to the forefront. Stay tuned.


Gil Morales

CEO and Principal, Gil Morales & Company, LLC
Managing Director and Principal, MoKa Investors, LLC
Managing Director and Principal, Virtue of Selfish Investing, LLC

At the time of this writing, of the stocks mentioned in this report, Gil Morales, MoKa Investors, LLC, Virtue of Selfish Investing, LLC, and/or Gil Morales & Company, LLC had positions In BIDU, LNKD, NFLX, and LVS, though positions are subject to change at any time and without notice.

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